The economic situation in the UK and the economics hidden in the election debate. Also my initial views on Greece’s request for aid.

This week has seen the publication of quite a raft of economic statistics for the UK and by the time we get Gross Domestic Product figures for the 1st Quarter of 2010 later this morning we will have a good idea of the state of the UK economy. Last night also saw the second of the televised leaders election debates in the UK and having written on the subject of our politicians economics I feel it is a good time to analyse what if anything has changed since then. I am aware also that the economic situation of both Greece (where some government bond yields now exceed 10%) and Portugal, and feel that they are a spectre hovering in the background of our economic debate. 

My view on “the elephant in the room” 

Here are my views on this from last week. They are still true. 

Yesterday Vince Cable the prospective Chancellor for the Liberal Democrats used this evocative phrase to describe the question of the UK fiscal deficit and of course this also has an implied view for the National Debt. However this is an area where all three main political parties have similar flaws in their plans. If you look at the three published manifestoes there is a hole in each of them of a similar size, £30 billion. So in truth none of them are being transparent and honest in their spending pledges. So the answer to the question what are they not telling us? Is in economic terms £30 billion. This is just over 2% of our Gross Domestic Product (GDP). Put another way it is around a quarter of the annual cost of the National Health Service. 

Just to put the size of this “black hole” into further perspective none of the three main political parties have specified credible plans to cut spending by more than £10 billion. So there is quite a difference of scale here. Our political class are misrepresenting the facts and are attempting to mislead voters. This will not help you tonight in choosing but please be aware they are all dissembling. What they do after the election will not match the promises they are making now. 

Kenneth Clarke 

I was interested to see Kenneth Clarke give a statement pretty much agreeing with me 

“The most urgent question in this campaign is, quite simply, which party is capable of tackling public spending and getting a grip on the deficit.” 

Now like Vince Cable, Kenneth Clarke is a generally respected politician. He was Chancellor through an austerity phase in the early 1990s and this was a period that led to an economically successful recovery for the UK. However one should also be aware that it was a policy he was and indeed is keen on (Europe and a single currency) which got us into a mess in the first place. 

 Comment on the reality 

The reality is that Kenneth Clarke has not been able to get his own colleagues in the Conservative party to explain how they would cut public spending and reduce the deficit. The other two main parties are in exactly the same position in that they have no explanation either. I notice that Nick Clegg last night was talking of an economic council combining politicians from all sides as well as the head of the FSA and the Governor of the Bank of England to deal with the deficit. This sounds worthy but of course neatly passes the problem to after the election and so it would appear we will see no real Liberal plan until then. For Labour well they are in government and therefore in fact have and had the most onus on them to publish a credible plan for this reason but they chose not to do this. They appear to feel that what they think is good politics wins over good economics. 

You see whoever wins on the 6th May will find that their plans and economic ambitions will be hindered and possibly scuppered by the urgent need to address our fiscal deficit. In that sense all three manifestos are a misrepresentation. There are two big questions which have not been answered by any party. 

1. Exactly how will the required (large) squeeze on public spending actually be achieved? 

2.Official forecasts for growth in the UK economy are very optimistic, what will happen if these are not achieved in reality? 

Our political parties are in effect elbowing each other and fighting for the same piece of turf, none of them have the courage to say this is wrong we should move to new ground. They are frightened of standing out and being accused of peddling misery and bad news. 

National Insurance is it a tax on jobs? 

No-one seems to be fully explaining this issue and as it is talked about a lot I thought that I would settle this matter. Let us take a look at the Conservative proposal according to their manifesto. You need to be careful as some of the versions on their website describe their plans incorrectly and rather bizarrely as I shall explain below miss out the jobs tax bit! Ooops. 
 

We will make the following changes in April 2011, relative to Labour’s plans: 

• raise the primary threshold for employees National Insurance by £24 a week and raise the Upper Earnings Limit by £29 a week; and, 

• raise the secondary threshold that employers start paying National Insurance by £21 a week. 

So it is quite simple. Their move on employees National Insurance is not a jobs tax as employees National Insurance is a tax paid individually and is analagous to income tax. I doubt whether anyone is calling income tax a jobs tax. However the second part of their change affects employer’s costs as it is paid by them and so it can reasonably be called a jobs tax. This is based on the view that raising one of the costs of employment is likely to lead to less employment. I have not noticed any of the political parties explaining this policy properly which makes me wonder if any of them really understand it. 

I notice that there does not appear to be any mention at all of the self-employed….. 

Comment 

The more misrepresentation and sticking their collective heads in the sand I see from our politicians the more I wonder if a hung parliament might actually be a good idea. At least it would create an immediate crisis and we could start on actually acknowledging it and thereby dealing with it. 

Although a hung parliament could also show up a flaw in our political system as there are quite plausible routes where Labour could come third in the popular vote and end up with the largest number of seats. This  is because “hard-core” Labour seats tend to be smaller constituencies in terms of numbers than “hard-core” Conservative ones. Although perhaps I am getting ahead of myself as only one poll really counts! But I think there is a possible flaw and it could cause even more disaffection with politics if it took place. 

In our economic history we have very rarely cut public spending in real terms. We need to cut not only relative to GDP or in real terms we need to cut actual cash amounts too. Apart from post-war periods we last did that in 1931 and 1921/22 according to Lombard Street Economics. 

This weeks economic figures 

These confirmed trends which we already knew I think. 

1. We have an inflation problem which is higher and more persistent than many expected. 

2. Our unemployment picture is confused but our trends for employment (falling) and inactivity (rising) are not confused. As this year progresses we will need our private-sector to create jobs as it is plain our public-sector will need to start shedding them. 

3. Our national finances are in poor shape and as I have discussed above there is of yet no plan to fix them. The financial year just ended turned out to be a little better than official forecasts but contrary to the official view for the future I have concerns for the next year couple of years as follows. 

a. Our economic growth forecasts are very optimistic. 

b. Our unemployment forecasts are also rather optimistic going forward particularly as I have highlighted above there needs to be cuts in the public-sector. 

c. Tax changes may have shifted revenue into the year just gone and out of the year to come. 

d. Under the self-assessment system taxpayers now have the opportunity to update their future tax payments based on last year which overall was a poor one for the economy. 

Today’s GDP figures 

 According to the Office of National Statistics the UK economy grew by 0.2% of GDP in the first quarter of 2010. My first point is that these are only a first estimate and should be treated with caution accordingly (the ONS estimates a possible error of 0.2%, I would be more cautious than that). My second is that they confirm us as being out of recession for now as I have always been uncomfortable with the concept that it takes two quarters to go into recession but only one to come out of it. Breaking the figures down there is a good side which is manufacturing (+0.7%) and a weaker side services which were up by 0.2% which is disappointing. 

Put another way the figures mean that we are progressing as if we were back in 2005. Again breaking these numbers down and using 2005 as a benchmark of 100 then our manufacturing output is 89.8 and total services are at 105.2. This is rather revealing I feel. 

Update 11:45am Greek Developments

Greek Prime Minister George Papandreou has in a televised address called for the activation of the European aid package. This follows a day of wild rises in Greek government bond yields with her two-year bond’s yield rising to over 11% at one point before closing at over 10%,and a downgrade in her sovereign debt status to A3 by Moody’s ratings agency.

Comment

Whilst markets are likely to receive this news initially favourably, as time goes by their minds are likely to become more focused on the issues I raised on the 16th April. These relate to flaws in the euro zone “rescue plan”.

Even if Greece does sign up to the plan further problems with it have come to my mind.

1.Primacy. Who is in charge? Will it be the European Commission? the European Central Bank? the IMF? If you wished to set-up something which was unwieldy and inflexible this is exactly how to do it. The IMF does sometimes co-operate with other institutions but it is used to having primacy and control.

2. Conditions. We still do not have any and we will need some. Usually this would be considered the role of the IMF but we hit point one again.

and at the same time I made some suggestions as to how things might be improved.

My suggestions are as follows

1.Greece should ask for the money offered

2. The IMF should be given primacy and it should set terms and conditions for Greece. Looking at its track record these will involve a further dose of austerity.

3. Greece should begin negotiations on its debt to have a technical default where there is a “haircut”. I have suggested 15% as a value for the reduction as it would put her in the position she was in a year ago. Without a change even moves one and two will not help her solvency problem and the rescue plan will eventually fail.

4. Speed is of the essence. Too much time has already been wasted.

So far only point one of my suggestions has actually been addressed. In the meantime we have seen resistance to the plan from political parties in the largest expected contributor to the European portion of any aid package Germany. They may not stop the plan but they could certainly delay it.

Furthermore the amounts discussed so far seem sufficient to get Greece through 2010 but this to my mind begs the question of 2011 and 2012,what happens then? We have seen the difficulties in getting together an aid package of this size…

Also with Greek ten-year bond yields going above 8% then those going to the German Constitutional Court have a stronger case for arguing that a rate of 5% is in fact a subsidy.

So Greece is clearly not out of the woods yet. However it has been pointed out to me that St George Day is also recognised in Greece and so I would like to wish all English and Greek readers a happy (in the circumstances) St. Georges Day.

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17 thoughts on “The economic situation in the UK and the economics hidden in the election debate. Also my initial views on Greece’s request for aid.

  1. Forgive my ignorance Shaun, but what is the relevance of 2005? I think you are right about the hung parliament, at least then nobody gets the blame for the fiscal tightening, if it comes at all (which I am not convinced of).

    • Hi Max
      I was trying to make two points and perhaps by trying two in one go I did not make them as clear as I would like. They are.

      1. Our recession and subsequent recovery has in effect left us in the position we were in back in 2005, that is in terms of overall economic output. At the time this was seen as a recovery from 9/11 and indeed a boom. I think this also poses a question for our current state of affairs as if 2005 was in effect okay what changed between then and now to make returning to it so bad for our public finances for example?

      2.Whilst economic output overall is at 2005 levels there have been changes in its composition. So that manufacturing is weaker and services stronger. This is not so re-assuring as going forward most forecasts have big hopes for our manufacturing sector.

  2. An excellent summary of the UK realities, as usual Shaun.

    I would just make one point: “This is because “hard-core” Labour seats tend to be smaller constituencies in terms of numbers than “hard-core” Conservative ones. Although perhaps I am getting ahead of myself as only one poll really counts! But I think there is a possible flaw and it could cause even more disaffection with politics if it took place.” But surely this has already taken place? The present (or last) government was elected with a significant working majority despite only receiving a distinct minority of the possible votes. That means that the wishes of 80% or so of the electorate were already completely ignored by our ridiculous political system?

    • The electoral system we have plays to this faustian pact of using state resources to protect interest groups.Accordingly Labour can rely on somr rock solid seats where benefit dependency is rife,conversely the Conservaties uses unaffordable tax advantages to appeal to safe ‘middles class’ seats depend on service sector employment.

      However both of these interest groups operate within a framework that is unaffordable and will either be slowly or suddenly dismantled as public spending is cut.

      It is probably the next election where the core voters that prop the currtent system are blown out of the water. This will open the door from new extremist parties to emerge.It will be ugly.

      Elsewhere (so far) Ms Merkel has yet to comment on the Greek fire alarm activation.

      • I’ d be interested if you could give more details of what the unaffordable tax advantages are that the Tories offer vis a vis safe middle class seats dependent on service sector employment? (I’m not disagreeing, by the way, just genuinely would like to know what they might be.)

      • It’s a fair question and I,m worried about getting political on what is a very impartial blog.
        My starting point is that any allowance from the state against a tax on earned income is unaffordable ,so long as the state carries a structural financing deficit. On that basis we cannot afford.
        Higher rate tax relief on Pension Contributions
        Tax Relief on Cash AVC contributions
        Tax Relief on ISA investments
        Capital Gains Allowances

        I’m not for a moment saying these tax measures have no merit,merely they currently are not affordable and are dispensable without causing undue hardship.

      • Thanks for the reply. It was the bit about service sector employment that confused me, I was pondering over what tax perks were specifically relevant to that, silly me!

      • Not at all,it’s silly me for not writing with appropriate clarity.The service sector comment was a bit of a throwaway .What I was trying to drive at was how on one hand with half the country dependant of public sector jobs and benefits,the other half is equally dependant on a service sector that has grown to unsustainable levels.

        On further reflection it is true that both parties have been willing participants in this fragile plan.

        If comments here were restricted to 5 words I could have better put it as “Britain is a pyramid scheme”

      • I like this current round robin which explains UK fiscal policy!

        A DAY IN THE LIFE OF A 50 POUND NOTE

        It’s a slow day in a little northern town called N——ham. The single mothers are packed tight into the coffee bars.
        There’s a chill in the air, and the streets are deserted. Times are tough, everybody is in debt, and everybody lives on credit…………..
        On this particular day a banker is driving through town. He stops at a local hotel and lays a £50 note on the desk saying he wants to inspect the rooms upstairs in order to pick one to spend the night.
        As soon as the man walks upstairs, the hotel owner grabs the £50 and runs
        next door to pay his debt to the butcher.
        The butcher takes the £50 and runs down the street to settle his debt
        to the farmer.
        The farmer takes the £50 and heads off to pay his bill at the
        supplier of his animal feed.
        The guy at the Farmer’s Co-op takes the £50 and runs to pay his debt
        to the local prostitute, who has also been facing hard times and has
        had to offer her “services” on credit.
        The prostitute rushes to the hotel and pays off her room bill with the
        hotel owner.
        The hotel proprietor then places the £50 note back on the counter so the
        banker will not suspect anything.
        At that moment the banker comes down the stairs, picks up the £50 and states that the rooms are not satisfactory, pockets the £50 and leaves town.
        No one produced anything. No one earned anything.
        However, everyone concerned is now out of debt and now looks to the future
        with great optimism.

  3. I completely agree with you Shawn on Greece.. it’s all good this year; lets see what 2011 brings. Any thoughts on Portugal ? CDS rates going up.. this is how Greece’s crisis began..

    • Judging by the previous announcements made by EU ministers, the fact that Greece has now asked for assistance does not (to me at least) mean that Greeces problems are reduced either this year or any other.

      To my knowledge not one parliament across the Eurozone has agreed the bailout as yet. IF they do each individually agree a bailout package then what conditions will be imposed by those EU members on the Greek Government in return? We already have press reports of German ministers demanding more austerity from Greece in return and even calls for Greece to leave the Euro. Then there will be similar concerns over any further austerity imposed by the IMF.

      The icing on the cake will be the increasing civil unrest inside Greece and the further damage that will cause their shrinking economy.

      Never count your chickens until they are hatched and if I was a Greek finance minister I wouldnt be expecting any big fat Euro cheques any time soon judjing by the way the EU constantly seems to fudge every decision.

    • Hi Mr.Kowalski
      I am currently studying Portugal and her economic history over the past 15 years or so to get a view on the trends in her economy. There are clear differences with Greece I feel but I also feel that the markets are now in a phase where they are hunting for weaknesses and Portugal does have some for example she has had her own “lost decade”of slow growth as I said in reply to Johan, which she has tried to respond to but the “credit crunch” knocked her off course. Her geographical location (which I have personally enjoyed in terms of climate and scenery) in this instance does not help because she trades a lot with her Iberian partner Spain who of course also has problems.
      So in short it is starting to look as if some of the comparisons with Greece are a little unfair but I also tend to feel that in this market mood as the little girl in the film Aliens says to Ripley “it won’t make any difference”

  4. I’m a tad more optimistic, at least in the short term. I think Germany and the rest of the EU parlaiments will agree to the aid, despite court challenges and loud grumbling. Greek unions will strike, perhaps riot; their unemployment will shoot up. Still and all, I say Greece makes it thru this year. But as time goes by, their economy will continue to contract, taxes will have to go up again next year for them to make their targets, and at some point, the pain will get to the point where the Greeks simply throw up their hands and a “negotiated default” will occur. This even assumes that Germany and the rest will agree to cough up another $50bln in loans next year to keep them afloat.

    • Mr K,
      I think your prognosis is probably correct as I now see the Germans are being told they are in fact protecting their own currency by helping Greece. What I cannot understand is why any Greek politician would want to go down this road? The further they travel the less options they end up with when the inevitable happens. It would seem to make more sense to take a negotiated default and exit from the euro now. At the end of the day they are borrowing money to pay debt and running costs, it isn’t being used for investment which will produce a compound return.

  5. As I run through the whys and wherefore I seem to continually return to some fairly simple questions/assumptions which I just don’t “get”. And until I “get” them I see little hope for my understanding of the whole thing to progress.

    * Say Greece defaults or restructures their public debts. Why does this have anything to do with them having to leave the Euro?

    * If Greece were to leave the Euro this would arguably give them a policy lever that would allow them to avoid an explicit default – but I would think that the pain confusion and political and economic cost of first forcibly converting their Euro liabilities to New Drachma and then immediately pulling the inflation lever on all the unhappy unwilling new holders of New Drachmas would be an order of magnitude worse than simply dealing with things as they are now under the Euro (which is apparently too painful?).

    * Say Greece gets bailed out with some net subsidy (suitably deniable) flowing to them in order to get them through their solvency problems. A happy ending to the contagion contingency, holders of Greek debt in the European financial system up with 100 cents on the Euro. But why is a leaky transfer from the left pocket of Europe into the right pocket of Europe a better way for Europe to deal with the problem? (the leaks and drips being the non-European holders of Greek who are also kept whole)

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